Following its announcement in the October 2022-23 Federal Budget, the Federal Government released Treasury Laws Amendment (Off-Market Share Buy-Back) Bill 2022 (exposure draft legislation) on 17 November 2022. Learn how the exposure draft legislation proposes to amend the share buy-back provisions in Division 16K of the Income Tax Assessment Act 1936.
Following its announcement in the October 2022-23 Federal Budget, the Federal Government released Treasury Laws Amendment (Off-Market Share Buy-Back) Bill 2022 (exposure draft legislation) on 17 November 2022.
The exposure draft legislation proposes to amend the share buy-back provisions in Division 16K of the Income Tax Assessment Act 1936 specifically for listed public companies, to align the tax treatment of off-market share buy-backs undertaken by these companies with the tax treatment of on-market share buy-backs. This will ensure that where a listed public company undertakes an off-market buy-back of shares or non-share equity interests, no part of the purchase price in respect of the buy-back will be taken to be a dividend.
The amendments also include an additional integrity measure in respect of selective share cancellations by a listed public company, where consideration for the cancellation of a membership interest, as part of a selective reduction of capital, will now be unfrankable. However, the tax treatment of off-market share buy-backs or selective share cancellations undertaken by private companies will not change.
When the exposure draft Bill becomes law, the amendments will apply retrospectively to buy-backs and selective share cancellations undertaken by listed public companies that are first announced to the market on or after 25 October 2022.
Current share buy-back rules
If a company buys back shares from shareholders, the tax treatment for shareholders depends on whether the share buy-back arrangement was an on-market or an off-market share buy-back. An on-market buy-back generally happens if the share is listed on a stock exchange and the buy-back is made in the ordinary course of business of that stock exchange. Any other buy-back is an off-market buy-back.
Off-market share buy-backs
For current off-market share buy-backs, there are generally two components: The capital component and the dividend component. The portion of the buy-back price that is debited to the share capital account is deemed to be the consideration for the disposal of the shares for CGT purposes, subject to certain adjustments. Then, as much of the buy-back price as exceeds the part of that price that is debited against the company’s share capital account, or non-share capital account, is treated as a dividend paid to the shareholder by the company out of profits on the day the buy-back occurs. The shareholder may be assessable on the dividend and franking credits may be available (this apportionment may be subject to adjustment by the Tax Commissioner if he considers the arrangement is designed to obtain a capital benefit).
On-market share buy-backs
For on-market share buy-backs, currently, no part of the purchase price in respect of the buy-back is taken to be a dividend. The total amount received by the shareholder is, for general income tax and CGT purposes, treated as consideration received in respect of the sale of the shares.
Further, although there is no deemed dividend, a franking debit will arise in the company’s franking account on the day of the buy-back. The franking debit will be equal to the franking debit that would have arisen if the buy-back had occurred off-market and the dividend had been franked at the entity’s benchmark franking percentage, or otherwise 100 per cent.
New off-market share buy-back rules
The proposed amendments apply only to listed public companies that undertake off-market share buy-backs. In these circumstances, no part of the purchase price in respect of the off-market share buy-back is taken to be a dividend in the hands of the shareholders (similar to the current rules for on-market share buy-backs). As a result, the shareholders will not be assessable on any part of the purchase price as a dividend and will only be assessed on the sale of the shares as a capital gain or loss, or as a revenue gain or loss.
These changes were proposed due to concerns from Treasury and the Australian Taxation Office (ATO), that the difference between on and off-market share buy-backs was being exploited to provide franking offsets to participants in share buy-backs at the expense of federal government revenue.
New franking debit provision
In addition to the above changes, where an off-market share buy-back is undertaken by a listed public company, the proposed amendments require the company to debit its franking account for the part of the buy-back that is not debited to the company’s share capital account. The amount of the debit will be equal to the franking debit that would have arisen if the company purchased the shares off-market and it were not a listed public company. This results in a reduction of the company’s franking account balance, even though no part of the purchase price in respect of the off-market share buy-back is taken to be a dividend in the hands of the shareholders.
The draft explanatory memorandum states this franking debit is to ensure that shareholders continue to benefit from imputation credits proportionate to their shareholding in the company after the buy-back occurs. It appears this is achieved by the generally equal proportionate reduction of the company’s shares and the company’s franking account balance.
Selective share cancellations
The exposure draft Bill also contains further integrity measures which were not announced in the October 2022 Federal Budget. These new measures relate to selective share cancellations which are intended to prevent listed public companies using selective reductions of capital as an alternative way to take advantage of the concessional tax status of shareholders as part of their capital management activities.
As a result, any distributions by a listed public company that is consideration for the cancellation of a membership interest in itself, as part of a selective reduction of capital, will now be unfrankable. Currently, this dividend - to the extent that it is not debited to the share capital account - is generally a frankable distribution.
In line with the amendments to off-market share buy-backs undertaken by a listed public company, the company will also be required to debit its franking account in respect of selective reductions of capital.
Treasury has requested comments on the exposure draft legislation by 9 December 2022.
When first announced by the government in the October 2022 Federal Budget, this measure did not contain much detail regarding the extent to which the amendments would apply, other than to say:
‘The Government will improve the integrity of the tax system by aligning the tax treatment of off-market share buy-backs undertaken by listed public companies with the treatment of on-market share buy-backs. This measure will apply from announcement on Budget night 25 October 2022.’
Also absent were details regarding the additional integrity measures, which prevent listed public companies using selective share cancellations which will result in distributions being treated as unfrankable. All of which will be backdated to apply from 25 October 2022 (Budget night). At BDO, we are concerned that the government has not provided sufficient notice of the changes to selective share cancellations. We request the Government consider postponing the start date for these measures to at least 17 November 2022 - The date the exposure draft was released.